Inside and outside super: A different tax regime for older Australians

The recent federal Budget highlights that older wealthier Australians enter a different tax regime from age 55, becoming even better from age 65.

Consideration of this different tax regime is critical for effective retirement planning, particularly given the proposed Budget changes to superannuation. (Rice Warner’s BUDGET 2016 – SIMPLY SUPER.)

It seems that the days of the straightforward, single-minded strategy of pumping huge contributions into super with the goal of eventually receiving all savings as a tax-free pension are over for many higher-balance, higher-income members.

Financial planners are likely to increasingly focus on Australia’s dual tax system (one being for older individuals, the other for the rest of us) when planning their clients’ investment portfolios inside and outside superannuation.

In turn, this should provide advisers with greater flexibility and opportunities to “re-engineer” their clients’ affairs using a multiple-portfolio approach.

Consider a simplified example of a retiree over the super preservation age who has at least three portfolios: an account-based superannuation pension (or perhaps a transition-to-retirement pension if still doing some work), a superannuation accumulation account and at least one non-superannuation portfolio.

Each portfolio is intended to make the most of the different tax regime applying to older Australians (as summarised below).

PORTFOLIO ONE. ACCOUNT-BASED SUPER PENSION

Scenario: Given the Budget proposals, this account is likely to hold up to $1.6 million as at July 1, 2017– or a total of $3.2 million for a couple with equal pension account balances. In this example, the pension is intended to provide, at the very least, the retiree’s day-to-day expenses. At a 6% earning rate, $1.6 million would (initially) produce $96,000 a year tax-free or twice as much for a couple with equal balances of this size.

Detail: Once members reach their superannuation preservation age (at least 56 if born after July 1960) and are no longer “gainfully employed”, investment assets supporting a superannuation pension are exempt from tax. This does not change under the Budget proposals.

When a member turns 65, earnings of superannuation assets backing a pension become exempt from tax – whether or not the member is still working. Further, the pension income itself is not taxable if the member is over 60. These tax exemptions will not change under the Budget proposals.

However, the Budget does propose an indexed $1.6 million cap on the amount that can be transferred into a pension account from July 1, 2017. Amounts already in a pension account above the cap at that date must be either transferred to an accumulation account or out of superannuation. Most large balance members will take the former option.

PORTFOLIO TWO. ACCUMULATION PENSION ACCOUNT

Scenario: Many wealthier retirees with more than $1.6 million in their pension accounts at July 1, 2017 (discussed above) will choose to transfer the excess to an accumulation super account for use as their retirement nest-egg. This will provide money for overseas travel, home renovations, medical expenses, a new car, family emergencies and the like.

Detail: Moving excess assets over the $1.6 million cap to accumulation will increase the amount of tax paid by these retirees. However the standard superannuation taxes (up to 15%) are highly concessional and unaffected by Budget proposals.

These accounts are also more flexible/useful for retirees:

• There is no ceiling on the amount that fund members can hold in their accumulation accounts.
• The changes allow fund members aged 65 to 74 to make super contributions from July 2017 without having to meet the work test.
• An additional benefit is that members would be able to make spouse contributions for non-working spouses aged up to 74.
• The assets in the accumulation phase will not be subject to minimum drawdown requirements.

Although the budget places an indexed $500,000 lifetime cap on non-concessional contributions most couples will have considerable scope to use these opportunities to grow their retirement balances.

This means retirees can potentially keep building-up their accumulation accounts into old age and would be able to make concessional contributions of up to $25,000 by claiming personal tax deductions against their non-super investment income.

PORTFOLIO THREE. NON-SUPER INVESTMENTS

Scenario: This is where a retiree can enjoy considerable flexibility and freedom without the laws controlling superannuation investments. This third portfolio could be seen as being like a SMSF portfolio without all of the stringent rules and the oversight of the tax office as regulator of self-managed super. Financial planners will increasingly develop strategies for clients such as using discretionary trusts to deal with this proportion of a retiree’s assets.

Retirees are likely to use this part of their investment portfolio for estate planning (unlike superannuation, there are no potential tax implications for non-dependent beneficiaries) and in some cases even to hold geared assets receiving the tax benefits of negative gearing against fully-taxable, non-super income.

Detail: Informed retirees using a three portfolio approach will tend to mix-and-match their non-super and super portfolios to get the most-effective result.

Once you have attained age 65, it still makes sense to hold some assets outside super. The combined benefit of the standard $18,200 tax-free threshold, the Senior Australians and Pensioners Tax Offset (SAPTO) and the Low Income Tax Offset (LITO) means that an eligible couple could receive an income of up to $57,948 without paying any income tax.

There seems little doubt that more retirees in future will hold multiple super and non-super portfolios using strategies to ensure the portfolios operate smoothly together. The degree of possible flexibility and innovation from such an approach may surprise some retirees.